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The European Periphery: Between a Rock and a Hard Place

20. February 2013, von Alexandre Abreu, Comments (1)

The strategy of the Portuguese government in the context of the current crisis, which is essentially aligned with the prescriptions of the ECB-EC-IMF troika, revolves around two axes that, indeed, were also typical of the policy packages implemented in the global south from the 1980s onwards: stabilisation, which in this case refers to slashing public expenditure and curbing the current account deficit; and structural adjustment, which basically refers to labour market deregulation and the privatisation of those companies that still remain(ed) within the public realm.

In the context of this strategy, the resumption of a growth trajectory (even while adopting a permanently contradictory fiscal policy) is presented as hinging on the latter structural reforms. The alleged mechanism, which will be well-known to the readers of this blog, is to undertake an internal devaluation by forcing wages down, in order to mimic the external devaluation of a no-longer existing Portuguese currency. Wage compression across the board, promoted through various mechanisms (the downward pressure of unemployment upon wages, the nominal freezing of the minimum wage, labour market deregulation, etc.) is expected to translate into an increase in the price-competitiveness of Portuguese exports, and these in turn are expected to drive growth.

So what is wrong with this story? Basically, the problem is that it misrepresents the determinants and obstacles affecting the competitiveness of the Portuguese economy. In a paper published in Voxeu in 2011, Jesus Filipe and Utsav Kumar have shown, among other things, that the competitiveness problems of the European periphery, and of Portugal in particular, cannot be traced back to the evolution of their aggregate labour costs, but rather to the composition of their export baskets: Portugal’s exports, much like China’s and those of the remainder of the European periphery, are concentrated in the product groups characterised by relatively lesser complexity (in the sense put forth by Hidalgo and Hausmann), while Germany’s and France’s, for example, are concentrated in the more complex categories.

In this context, the developments of the past 15-20 years have left the European periphery between a rock and a hard place: on the one hand, direct competition in the least complex product range has increased dramatically in the wake of the EU’s Eastern enlargement, China’s accession to the WTO and the EU’s trade agreements with Morocco, without there being any possibility of adjusting through currency devaluation; on the other hand, the possibility of upgrading the complexity features of the export basket has been denied both by Germany’s (and other core countries’) own wage compression in the past 10-15 years and by the fact that the instruments that make it possible to actively promote such an upgrade are effectively denied by EU and WTO rules, unlike what was the case when the most advanced industrialised economies undertook that upgrade themselves. Kicking away the ladder, indeed.

So that’s why this strategy will not work: becoming competitive through wage compression in the same product categories as China and Morocco, for example, without recourse to currency devaluation or trade protection at the EU level, would require cutting down wages to an extent that could only bring about massive immiseration – and even that would probably not do the trick, given such issues as economies of scale or differences in environmental legislation. That the benign alternative – upgrading export complexity – is not feasible, either, under the current EU and Eurozone constraints shows the scale and complexity of the predicament in which the European periphery currently finds itself, well beyond the temporal horizon of any stabilisation package or financial assistance programme – and, of course, does not bode well for the future of the Euro.

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Blog Authors

Adriaan SchoutAdriaan Schout

Dr Adriaan Schout is Deputy Director Research/Europe at Clingendael, Netherlands Institute of International relations. (read more...)

Alexandre AbreuAlexandre Abreu

Dr Alexandre Abreu is a 33-year-old Portuguese economist with a PhD from the University of London. Currently he is a lecturer in Development Economics at the Institute of Economics and Business Administration, Technical University of Lisbon, and a Researcher at the Centre for African and Development Studies of the same University.

Almut MöllerAlmut Möller

Almut Möller is a political analyst in European integration and European foreign policy. She is currently the head of the Alfred von Oppenheim Centre for European Policy Studies at the German Council on Foreign Relations (DGAP) in Berlin. (read more...)

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